It could stoke rural entrepreneurship like Alibaba's Taobao which would involve going beyond me-too e-commerce with just IT applications and building a feet-on-the ground logistics and distribution network. Amazon has just started doing it, and given its track-record with Jio, Reliance is most certain to go the full-hog in taking e-commerce (both on the seller and buyer sides) to beyond the top 10% of Indian market and into rural areas. It already has about 4000 Reliance Retail stores, 50 warehouses, and 4000 Reliance Jio outlets. A race between Amazon and Reliance could well turn out to be among the most interesting things to look for in the global e-commerce market itself, and unlike even in the US, Amazon is far from certain to emerge as a winner.

2. Mr Ambani has also called for an end to "digital colonisation", and ownership of Indian citizen's data by citizen's themselves and not by corporates much less foreign ones. Little to argue against this. It is also an open support for the Government of India's e-commerce restrictions and data relocation policies that would hurt foreign e-commerce and payment companies. The Government should promulgate the Personal Data Protection Bill 2018 and enact regulations that protect personal data across sectors, something which regulators especially in the US have been averse to committing to.

But in the coming days, this will most certainly provoke articles and op-eds accusing the Government of India of pandering to Reliance, even being captured by it. Without getting into the merits of any such allegation, it raises an interesting point about the dynamics of public policy regulations in such areas which invariably ends up favouring one or other large incumbents. Favourable public policy has played a critical role in entrenching the big American internet behemoths. The biggest lobbyists in the US have been the tech companies, and there too the largest tech companies. This blog has written several times about the capture of political institutions and rule-making by tech companies.

3. I will go further and argue that such levelling-the-playing field policies may perhaps be the only way to make markets with network effects competitive. The publicly-driven emergence of Union Pay and RuPay in China and India respectively could have been the only way to disrupt the rent-seeking market in payment gateways that the trio of American Express, Visa, and MasterCard had been enjoying for decades. The likes of Amazon, Facebook, and Google with their near monopoly over individual's data dominate their respective markets in the US and raise insurmountable entry barriers for competitors even in external markets. There is no reason to think why those privileges should be globally harmonised.

Surely, even with all the efficiencies and cutting-edge technologies associated, we would not want any market globally dominated by one or two firms, much less one which captures arguably one of the most important resources of modern economy, data. Further, whether we like it or not, the fact remains that individual data is being "colonised" by foreign companies and that too is not desirable. And all this becomes even more compelling when we realise that these behemoths have repeatedly failed on their fiduciary responsibilities, adopts socially harmful profit maximisation strategies, and their leaders have even demonstrated shocking incompetence with managing large organisations.

4. The roles being played by Amazon, Alibaba, Rakuten, and Reliance in their respective markets indicates that, for all the hype around nimble and small innovators, true disruption still requires deep pockets and large players.

5. Finally, the grouse of the foreign e-commerce firms and their supporters accusing the Government of India of whimsically changing the rules of the game is plain disingenuous. While the GoI has whimsically changed the rules of the game on many occasions, this is surely not one of the cases.

The original e-commerce policy while allowing ecommerce companies to run virtual "marketplaces" that connect independent sellers to consumers, had explicitly barred them from selling goods themselves and being online supermarkets. The foreign firms in turn gamed the rules by establishing local partnerships and creating new on-seller companies. The entity formed by Amazon's partnership with NR Narayanamurthy's Catamaran Investments, Cloudtail is the overwhelmingly largest seller on Amazon India. The new rules stipulate that no seller on online marketplaces can source more than a quarter of its inventory from a wholesaler linked to the marketplace, and bars sales on the marketplace by any entity owned by the marketplace or any of the its group companies.

This reminds me of Indian infrastructure companies who have bid aggressively, overlooking explicit provisions that would have made their sustainability unviable, in an attempt to bag the contract and get back to renegotiate the terms later. Companies like Amazon did exactly the same thing, accepting the GoI's e-commerce policy and entering the market, in the hope that they would be able to either continue gaming the extant rules or be able to lobby and change the policy itself.

Saturday, January 19, 2019

1. Fascinating article in FT by a neurosurgeon, Henry Marsh, on brains and artificial intelligence. Consider the technical challenge,

It consists of some 85bn nerve cells, each of which is connected to many thousands of other nerve cells, with some 150tn connections... There are significant practical limitations on the extent to which we can experiment and explore our own brains. The resolution of the best MRI brain scanners, for instance, is about one cubic millimetre, and one cubic millimetre of cerebral cortex can contain up to 100,000 neurons and a billion synapses. The temporal resolution is a little less than one second, and much cerebral activity is measured in milliseconds, so what we see with MRI scans are, in effect, blurred snapshots... The energy consumption of a human brain is 20-30 watts — a dim lightbulb. An exascale computer, capable of a quintillion calculations per second, scaled up to the size of a human brain, would consume hundreds of megawatts. Computer engineers talk of the “von Neumann bottleneck”, a problem with classical computer design in which memory is stored separately from the Central Processing Unit, and one of the reasons why computers use so much energy.

And on the limitations of modern AI,

The remarkable progress in AI in recent years is largely based on “neural networks” and machine learning... Neural networks only resemble brain networks in a very loose way. They consist of layered assemblies whose output can feed back and modify their input in accordance with a pre-programmed target, so that they “learn”. They are engines of statistical association and classification. They neither explain nor do they understand. They have no internal model or theory of what is being analysed. The literature, however, abounds in anthropomorphisms — AI programmes are said to “see” and “think”. Google’s DeepMind programme AlphaGo “vanquished” champion Go player Lee Se-dol. This is all nonsense. It is easy to get carried away. The predictive texting on your smartphone prompts you simply by calculating the probability of the next word from mindless analysis of previous text. Google Translate has trawled the entire contents of the internet without understanding a single word... all current machine intelligences can only perform one task. This form of intelligence is reminiscent of the patients described in some of Oliver Sacks’ writings — people who can carry out remarkable feats of calculation but are utterly helpless in normal society... The Holy Grail for AI is “general intelligence” — a computer programme that could not only play games with simple rules but also perform other tasks, such as speech and face recognition, without being re-programmed. On present evidence it looks unlikely that neuronal networks and deep learning will ever be able to do this.

And what to expect in the future,

I find it strange that some people are so certain that the arrival of “superintelligent” machines is only a matter of time. Filled with a fervour reminiscent of the Second Coming and the Rapture, they talk of the Singularity, a time when AI will equal human intelligence. This belief — which is all it is — often comes with the hope that the human brain and all its contents can be re-written as computer code and that we will find the life everlasting as software programs. These ideas are not to be taken seriously, although they certainly sell books... There is no risk, however, in the foreseeable future, of superintelligent AIs replacing us, or treating us as we have so often treated, and continue to treat, animals.

In 2007-08, about RMB 61⁄2 trillion of new credit was needed to raise nominal GDP by about RMB 5 trillion per year. In 2015-16, it took more than RMB 20 trillion in new credit for the same nominal GDP growth.

4. Upshot points to the latest research by David Autor which shows that while cities are the place to be for high skilled American workers, they may be becoming less so for low-skilled workers.

As to the reasons,

Mr. Autor attributes the declining urban wage premium in this chart to the disappearance of “middle-skill jobs” in production but also in clerical, administrative and sales work. Many of these jobs have gone overseas. Others have been automated out of existence. This kind of work, he argues, was historically clustered in cities (meaning the entire labor market around cities, within commuting zones). And because of that, workers with limited skills could find better opportunities by moving there. Now, the urban jobs available to people with no college education — as servers, cleaners, security guards, home health aides — are basically the same kind as those available in smaller towns and rural communities.

8. Bill Gates has a nice article which calls out the success of "financing and delivery" entities in global health care, like GAVI (children's vaccination), Global Fund (for HIV, TB, and Malaria), and Global Polio Eradication Initiative. Gates has spent $10 bn on the three entities which buy medicines and get them delivered to end-users. In terms of return to investment, Gates writes,

Suppose that our foundation hadn’t invested in Gavi, the Global Fund and GPEI and had instead put that $10 billion into the S&P 500, promising to give the balance to developing countries 18 years later. As of last week, those countries would have received about $12 billion, adjusted for inflation, or $17 billion if we factor in reinvested dividends. What if we had invested $10 billion in energy projects in the developing world? In that case, the return would have been $150 billion. What about infrastructure? $170 billion. By investing in global health institutions, however, we exceeded all of those returns: The $10 billion that we gave to help provide vaccines, drugs, bed nets and other supplies in developing countries created an estimated $200 billion in social and economic benefits... Institutions such as Gavi, the Global Fund and GPEI are the closest things that we have to surefire bets to alleviate suffering and save lives.

9. Finally, very good article by Chinmay Tumbe on internal migration in India, which is more than 100 m today.

Thursday, January 17, 2019

The farm sector challenge is arguably the biggest political issue in India. And given the sheer proportion of people involved, it is only right that the problem get the sort of attention. But I am not sure whether the solutions being proposed are likely to lead us afar.

All kinds of things are being proposed, though among those on the table, I am inclined to believe that the direct cash transfer is perhaps the best option. Nice comparison here of the different cash transfer options - loan waiver, MSP, and direct cash transfer - by Ashok Gulati.

But I am not sure whether even this would be enough, given the exclusion of tenants and the near impossibility of bringing them too into the fold. Telangana government managed to some extent mitigate this, thanks to high level political commitment and bureaucratic resolve. But to expect weak state capacity and socially more polarised states in North India to be able to do anything close is perhaps unrealistic.

The importance of some form of universal social safety nets assume significance here. India is still, for the major part in rural areas, a very poor country. Whatever the causes, it is perhaps the case that the dynamics of liberalisation, globalisation, and progressive politics (all of which accelerated in the noughties) has disrupted rural economies - internal (mostly informal) stabilisers have been unsettled and external forces have been disruptive. One can identify several ways in which the land, labour, and capital markets in rural areas have been disrupted by these forces.

It is for this reason that I am inclined to be cautious with policies like deregulation of agriculture land markets. Such policies are all great as part of a package of policies. But when implemented in silos, as is most certain given that this is just a simple statutory change and others in the package are mostly longer-drawn measures whose effective implementation will be constrained by weak state capacity, such deregulation on rural livelihoods can be, especially in the medium-run potentially more damaging and socially destabilising. Merely increasing value of land and providing the farmer with a booster shot of land sale windfall without any complementary increase in access to opportunities to sustainable livelihoods can be of limited value. A very distortionary real estate speculation induced equilibrium can be long-lasting. The strong connections of real estate market with black money and corruption only makes this more likely. The asymmetric nature of the impact of these measures is under-appreciated.

This paper has cross-country regressions on growth accelerations and growth maintenances and finds that only the latter led to inclusive growth, and the former without proactive engagement to promote inclusive institutions can be detrimental,

Once growth has accelerated, it is important to facilitate the emergence of inclusive institutions as the greater the inclusivity of institutions, the more likely that economic growth will be inclusive.

Just like trade, economic growth too has distributional consequences. While being beneficial in the aggregate, they leave us with winners and losers. A mix of both redistributive programs and inclusive growth promoting institutions are required. Like with trade, the losers are likely to be concentrated in pockets of geographies, population categories, or sectors. And like with trade, contrary to theoretical wisdom, adjustments rarely happen on their own. Discontent and social instability is never far away.

A program like the NREGS, even with its flaws, was a stabilising force given its universal social safety net nature. It was an inclusive policy measure. We need something like that, maybe one which is more efficient and less distortionary.

All the above is just a hypothesis. Unfortunate that there have been no serious macro-level studies of India's rural economy that examine such dynamics.

Wednesday, January 16, 2019

Investors in the UK’s busiest airports received £6.7bn in dividends in the past decade even as those airports issued billions of pounds in debt... The scale of the dividends has provoked criticism from some in the aviation industry given airports are imposing high landing charges on airlines — which are passed on to customers through air fares — and are preparing to invest in expensive new runways and terminal buildings... Payouts from.. Heathrow, which had 78m passengers last year... totalled £4.3bn since 2011, and in 2017 investors received £847m... At the end of September 2018, Heathrow had £13.8bn in net debt... Heathrow... is owned by a consortium that includes Spanish infrastructure company Ferrovial, Qatar’s sovereign wealth fund, a Canadian public pension fund and one of China’s sovereign wealth funds.

Asset skimming by way of dividend payouts and using leverage to finance investments is common place across privately owned infrastructure and has been a cause of controversy in UK.

In the decade between 2006 and 2016, Australian infrastructure bank Macquarie, owner of Thames Water, paid itself and fellow investors £1.6bn in dividends, while the utility was loaded with £10.6bn of debt, ran up a £260m pension deficit and paid no UK corporation tax. The UK’s third and fourth busiest airports, Manchester and London’s Stansted, are both owned by the Manchester Airports Group, which has received around £760m in dividends since 2009. After payouts of £20m in the first three years, levels rose to more than £100m each year since 2015. Unlike Heathrow and Gatwick, Manchester Airports Group has a majority of local authority control, meaning dividends flow into the public purse: Manchester City Council owns 35.5 per cent and nine other Greater Manchester councils, 29 per cent. IFM Investors, owned by Australian pension funds, took a 35.5 per cent stake in 2013... Luton, the fifth-largest airport, is owned by the local council but is operated under a concession held by private equity firm AMP Capital (since April 2018) and Spanish airports operator Aena. It has paid out £152m in dividends since 2010.

Gatwick announced the sale of 50.01% stake from a consortium led by Global Infrastructure Partners (GIP) to the French transport group Vinci, the world's largest private airport operator with 46 airports. The deal values Gatwick at £8.3 bn.

It is also a reminder of how fast the industry has been privatised: over 50% of European airports have some private participation, up from 22% in 2010. Nearly half of winning bidders since 2008 have been financial investors... Returns have been juicy. GIP bought Gatwick for £1.5bn in 2009; it and its co-investors have made twice that by selling half of the airport, and earned £1.5bn in dividends in the interim.

Asset stripping by way of excessive dividend payouts, running up pension deficits, using excessive leverage to finance capital expenditure, sale-and-lease back arrangements on assets, and so on have become standard operating procedure for private owners of not just infrastructure assets. They are the second generation issues of infrastructure contracting that governments which concession out such contracts have to bear in mind.

It is imperative that governments in countries like India learn from these trends and incorporate provisions in model contracts that limit these practices. The experience of Delhi Airport Metro was a foretaste of what could happen in India with its concessions.

Make no mistake, there is a massive moral hazard lurking in these contracts. Everybody knows that the owners could easily recover their investments and walk away once the leverage becomes unsustainable and declare bankruptcy. Governments will have no choice but to takeover the assets and the pension liabilities. And given the bank exposures, especially public sector ones, those liabilities too would have to be borne by the tax payers. There is no point in crying hoarse then.

Monday, January 14, 2019

Have you ever thought about the differences between how international development agencies, social enterprises, and governments in developed countries view the same development challenge. Let me illustrate with the example of providing drinking water to rural areas.

The world of international development agencies view rural water supply in terms of providing hand bores or submersible borewells with delivery standposts (and often storage tanks). Accordingly, the multilateral and bilateral agencies spend billions of dollars annually in providing rural drinking water supply. There are also local variants, ranging from chlorination of local stream water to even local primary treatment based facilities.

The world of impact investing relies on social entrepreneurs who have devised innovative business and delivery models and technologies to deliver drinking water to people in villages on a sustainable basis.

Finally, there is the world of public service delivery in developed countries. Like urban areas, rural water supply in developed countries is provided by treating river/lake water and delivering them to a catchment of population through a network of pipes, storage tanks, and booster stations. How many developed countries, at any stage of their economic development, has had water supply in rural areas through bore wells?

I agree that in deeply resource constrained environments, piped drinking water in villages is a pipe-dream. But it cannot be also denied that all the other approaches currently being tried out are weak holding operations at best and deeply unsustainable ones too (how much ground water can you draw after all). And in at least the middle-income countries, piped water rural water supply is no longer an unrealistic pitch as Telangana is showing.

I can also understand the perspective of social enterprises. They are after all very marginal, almost negligible, players in addressing the global problem. Much the same applies to the non-profits too engaged with the problem.

The hold of this narrative is such that academics, philanthropists, aid agency personnel and others engaged with development are so consumed with such ideas as to be not able to view such first-order development problems in their true perspective. So the provision of rural roads and electricity supply and so on are evaluated for impact and value for money on a partial equilibrium basis.

Lant Pritchett has talked about "kinky development", the process of "defining development down",

Across the board, rich countries are backing away from the national development goals of poor countries, such as broad-based prosperity and effective government—i.e. productive economies, capable states, citizen controlled polities, and modern social interactions—towards a narrow agenda of low-bar goals, such as reducing “dollar a day” poverty; “completing primary schooling” (with no mention of quality of learning or education beyond primary); accessing basic water and sanitation; or focusing less on health and more on specific diseases. This is what I have called the “kinky development” agenda, as it doesn’t attempt to raise well-being across the board in developing countries, but just “kink” the distribution at arbitrarily low levels...

Consider in this context the “Power Africa” initiative announced by the Obama Administration in June 2013 to improve access for the 600 million Africans who lack electricity. The press brief claimed: “Power Africa will build on Africa’s enormous power potential, including new discoveries of vast reserves of oil and gas, and the potential to develop clean geothermal, hydro, wind and solar energy.” Of course coal—which in 2013 supplied 39 percent of all American electricity—is not mentioned, because both the US and the World Bank had announced a ban on funding coal plants. But then America’s 2014 Appropriations Act declared that Senator Patrick Leahy, whose state of Vermont relies on hydropower and who endorses hydropower for his state, was able to insert a clause to block support for precisely what Power Africa supports, and to do so with more or less political impunity. Perhaps promoting energy source diversification is why President Obama, while touring a power plant in Africa, thought it politically expedient to promote the Soccket ball. For those of you who still have not been introduced to this technological marvel, the Soccket ball is a soccer ball containing a battery that is charged by the kinetic energy of being kicked. This contraption is perhaps one of the best illustrations of the gap between development realities (the average Ethiopian consumes 52 kwh of electricity and the average American 13,246 kwh) and the “solutions” being proposed by the world’s elite: ban coal and limit hydro and if Africans want power, let them kick some soccer balls round.

There is something about the need to reimagine development away from what is the propagated narrative that has been foisted by external do-gooders. For far too long, the development narrative in India has been entrapped in what is peddled by international development experts. And rural water supply is but only one example.

At this stage of its economic development, India needs to shed the narratives that international development agencies have long peddled. No more handpumps and motor borewells, the time for treated piped water supply is well past. It needs more like the Telangana's Mission Bhagiratha and not some World Bank funded piecemeal rural water supply schemes.

Saturday, January 12, 2019

1. When delays and cost over-runs in infrastructure projects are passe, the Mumbai metro rail project appears an impressive achievement.

More than 8,000 workers and a fleet of 360-foot-long boring machines are working 24 hours a day—even through monsoon rains—to finish the 27-station, 21-mile subway through some of the world’s most densely populated neighborhoods, around the edge of one of Asia’s biggest slums, below an airport and under temples and colonial buildings to end at a green edge of forest where leopards still roam. The train is also cutting a path through the country’s religious traditions, legal system and every layer of its society, with challenges at each stop... Despite the difficulties, the subway, which was started in 2016, is now getting built at a pace of just over one mile a month. So far, 9 miles are complete. The $3.3 billion “Metro Line 3,” Mumbai’s first underground train, is on track to be finished and open by the end of 2021.

All the more so given that this is not a PPP but a purely public project.

2. A good article by Rohit Prasad in Mint about the farm loan waivers and corporate NPA write-off equivalence.

The equivalence arises when conditions warrant that the state must indirectly bear the burden of corporate NPAs by infusing funds into banks, as had happened in the US following the 2008 financial crisis and as is happening now in India. Equivalence can also be drawn when the problem of corporate NPAs repeats itself in the same sectors implying that, for some reason, banks keep lending to the same sectors even in the absence of structural improvements... Another ground for equivalence arises if the resources of the exchequer are used to buoy companies that would otherwise go into bankruptcy.

And this is interesting,

It is true that there has been a marked increase in the share of large loans in agriculture since 1990. In the same vein, the top 12 corporate houses received close to 15% of ₹70-80 trillion in total advances to the corporate sector and accounted for approximately 25% of the NPAs. The share of these borrowers in credit from the formal sector is almost the same as that of the entire agriculture sector. Four of these have been resolved within a year with about 52% recovery, representing only 14% of the dues from these 12 accounts.

It is believed that food prices for consumers must be kept low through restrictions on farmers and subsidies to consumers. The Organization for Economic Co-operation and Development (OECD) estimates that the average yearly revenue lost by Indian farmers between 2014 and 2016 on account of export restrictions, net of subsidies received, is ₹1.65 trillion... Historical performance shows that the credit quality of large corporate borrowers is not superior to that of agriculture/priority sector lending. In that context, interest rates charged by banks to large corporate borrowers have been kept artificially low and incommensurate with the risks involved.

3. Very interesting extract from a chapter by Christophe Jaffrelot on the Gujarat model in a new book on business and politics in India. Drives home the point about the relative superiority of growth that is built on SMEs than on a few large businesses. Sample this,

In the Nano plant, out of 2,200 employees, 430 are “permanent workers”. They earned ₹12,500 in 2016, whereas the informal workers earned about ₹3,300 a month... in 2013, Gujarati industry represented 17.7% of the fixed capital of India but only 9.8% of the factory jobs, whereas the industry of Tamil Nadu represented 9.8% of the fixed capital but 16% of the factory jobs.

4. The problem with many PPP policies is that about attendant downstream policy interventions that distort markets. For example, creating the private sector supply-side for Ayushman Bharat by providing land and/or viability gap funding to establish private hospitals in smaller towns. In addition, other subsidies like interest subvention on loans, electricity at residential rates etc are being proposed.

For weak states, which struggle to effectively regulate even those small number of existing PPP and other subsidised private facilities, this expansion of contract management may prove simply unmanageable. And worse, private hospitals know this is most certain and unscrupulous promoters will bid to capture the land or subsidy. Every major Indian city has public land allotted to large private hospitals with contractual obligations to provide some share of free/subsidised care to poor patients, and perhaps no city has been able to enforce them.

Further, apart from the monopoly problems in smaller towns, there is also the problem of private providers across the state coming together and holding the state to ransom demanding periodic unreasonable rate increases. The case of Aarogyasri is well known.

Amidst all this, nobody seems to be talking about the one obvious solution to address the problem, strengthening and expanding public facilities.

5. Fascinating account of the trolley problem in different cultures, economies, and geographies.

Participants from collectivist cultures like China and Japan are less likely to spare the young over the old—perhaps, the researchers hypothesized, because of a greater emphasis on respecting the elderly. Similarly, participants from poorer countries with weaker institutions are more tolerant of jaywalkers versus pedestrians who cross legally. And participants from countries with a high level of economic inequality show greater gaps between the treatment of individuals with high and low social status. And, in what boils down to the essential question of the trolley problem, the researchers found that the sheer number of people in harm’s way wasn’t always the dominant factor in choosing which group should be spared. The results showed that participants from individualistic cultures, like the UK and US, placed a stronger emphasis on sparing more lives given all the other choices—perhaps, in the authors' views, because of the greater emphasis on the value of each individual. Countries within close proximity to one another also showed closer moral preferences, with three dominant clusters in the West, East, and South.

6. Ananth points to this excellent Lynn Stout article which lays bare the critique against modern finance. Its questions the arguments about finance's role in capital raising, liquidity provision, and resource allocation. This is the summary,

Doctors and nurses make patients healthier. Firefighters and EMTs save lives. Telecommunications companies and smart phone manufacturers permit people to communicate with each other at a distance. Automobile executives and airline pilots help people close that distance. Teachers and professors help students learn. Wall Street bankers help—mostly just themselves.

Most research on heuristics and biases in financial decision-making has focused on non-experts, such as retail investors who hold modest portfolios. We use a unique data set to show that financial market experts - institutional investors with portfolios averaging $573 million - exhibit costly, systematic biases. A striking finding emerges: while investors display clear skill in buying, their selling decisions underperform substantially - even relative to strategies involving no skill such as randomly selling existing positions - in terms of both benchmark-adjusted and risk-adjusted returns. We present evidence consistent with limited attention as a key driver of this discrepancy, with investors devoting more attentional resources to buy decisions than sell decisions. When attentional resources are more likely to be equally distributed between prospective purchases and sales, specifically around company earnings announcement days, stocks sold outperform counterfactual strategies similar to buys. We document managers' use of a heuristic that overweights a salient attribute of portfolio assets - past returns - when selling, whereas we do not observe similar heuristic use for buys. Assets with extreme returns are more than 50% more likely to be sold than those that just under- or over-performed. Finally, we document that the use of the heuristic appears to a mistake and is linked empirically with substantial overall underperformance in selling.

8. Nice article by Shailesh Chitnis in Mint on the state of startup universe. Among the world's fastest growing startups, just 9% are apparently doing truly innovative and cutting-edge work. Just 27 of the world's 289 unicorns, which have sucked in $980 bn in investment capital, are creating innovative new products. Sample this on how innovation is getting more expensive,

Nicholas Bloom, an economist at Stanford University, and his colleagues studied research productivity across a variety of sectors. Their findings suggest that the cost of finding new ideas has increased, both financially and in the number of researchers needed. In aggregate, they compute that research productivity falls in half every 13 years. To maintain a constant growth in per capita GDP, the US must double the amount of research effort every 13 years. Simply put, coming up with new ideas is getting more expensive... The number of researchers required to double chip density today is more than 18 times larger than the number required in the early 1970s.

9. Finally, from Marginal Revolution, this is a superb economics cheat sheet.

Friday, January 11, 2019

But these engines are stuttering on both sides of the divide, developing and developed countries for contrasting reasons. In developing countries rapid urban expansion has been associated with sprawls, deficient infrastructure, traffic congestion, unaffordable housing, and slums and squatter settlements, all of which threaten to choke urban growth. In developed countries, urban growth has been associated with gentrification and sky-rocketing housing prices which have priced out all but the richer sections of the population from cities.

You don’t want to become Manhattan (too dense), Portland (too twee), Boston (too expensive), Seattle (too tech-y), Houston (too sprawling), Los Angeles (too congested), Las Vegas (too speculative), Chicago (too indebted). San Francisco has come to stand for the most specific set of horrors. It is the place where extreme poverty and tech wealth occupy the same block, while the schoolteachers and firefighters all live two hours away... In truth, most of these cities have qualities other cities would reasonably desire. Denver has one of the country’s fastest-growing tech labor forces, with minorities and women relatively well represented in those jobs. Seattle and Portland have among the fastest all-around job growth. New York has some of the fastest-growing wages. San Francisco has unemployment well below the national average and household incomes among the highest in the country.

But San Francisco-ization and the other -izations don’t refer to the process of acquiring any of these good things. Rather, those terms capture the deepening suspicion of many communities that the costs of urban prosperity outweigh the benefits. The tech jobs and the high wages aren’t worth having if they come with worsening congestion, more crowded development or soaring housing costs... Once you let tech giants in the door, you have a homeless crisis. Once you allow more density, you’re surrounded by skyscrapers. Once housing costs begin to rise, the logical conclusion is San Francisco... It’s much harder to point to cities that have gotten all of this right — the growth without the congestion, the tech jobs without the homeless crisis, the affordable housing without the sprawl.

The challenge for cities everywhere is to become engines of inclusive economic growth. This would reconcile economic growth with exclusionist trends like gentrification, unaffordable housing, suburban sprawls et al. In fact, given the importance of urbanisation, this should become one of the defining challenges of our generation.

And in this direction, Citylab points to the new Minneapolis's comprehensive plan to promote denser affordable housing. The Minneapolis 2040 has been described as the most radical up zoning plan in in any US city. It upzones almost the entire city, 75% of which is currently zoned for single-family units, and allows for building four-floor triplexes in most of the city and higher density in transit zones. It also eliminates off-street minimum parking requirement, the fourth US city after Buffalo, Hartford, and San Francisco. The Minneapolis plan assumes significance since upzoning rows of single-family homes set behind landscaped front yards have hitherto been off-table in zoning debates across US cities.

Wednesday, January 9, 2019

This is very significant. Evidence from Alibaba's experimentation with Sesame credit scoring system raises doubts about the value of big-data based credit-scoring systems. Since Ant Financial launched it in January 2015, it still has not made lending decisions using Sesame credit scores.

Sesame, which is an opt-in feature of the Alipay mobile payments app, draws upon the biggest pool of non-traditional ratings data in the world. It synthesises details from hundreds of sources — ranging from purchases on Alibaba’s Taobao marketplace to subway fares — into a single trustworthiness number for each user, called a “Sesame score”. But one Ant Financial employee conceded there was a difference between “big data” and “strong data”, with big data not always providing the most relevant information for predicting behaviour, and analysts say the best predictor of whether someone will default on a loan in future is often their previous loan repayment history, rather than their likelihood of returning a rental car. Banking and transaction data remain fundamental to predictive credit scoring... Martin Chorzempa, a fellow at the Peterson Institute of Economics think-tank, agreed, saying trustworthiness is “very context specific”. “Someone evading taxes might always pay back loans, someone who breaks traffic rules might not break other rules,” he said. “So I don’t think there is a general concept of trustworthiness that is robust.”... Critics have also questioned how Sesame crunches thousands of data points into a single score, saying there needs to be a strong correlation between hundreds of different behaviours — from trashing a hotel room to stealing a mobile charger — in order for the metric to be meaningful.

And the Chinese authorities have even barred private credit rating agencies,

earlier this year, China’s central bank stopped allowing independent companies to provide credit ratings, and required all credit ratings to be given by a new public body called Baihang — effectively ending Sesame’s credit ratings business altogether.

This has forced Sesame to pivot to other use cases,

Sesame’s business now relies on tie-ups with hundreds of other companies. When a company joins the Sesame platform, it gives Sesame some of its user data, which helps inform Sesame scores. In return, Sesame helps the companies decide how likely different users are to violate their contracts. The companies often give perks to users with a high Sesame score, such as deposit-free rentals for umbrellas, bicycles or even apartments. Ant Financial will regularly promote the discounts on the Alipay mobile payments app... Analysts have compared the platform to a glorified loyalty card, rewarding users for buying Alibaba’s and its partners’ products, but not predicting behaviour.

This is a cautionary tale for the hundreds of start-ups in developing countries, supported by venture capital, seeking to use various types of digital activity trails to develop credit worthiness measures for poor people and for small entrepreneurs. If Alibaba with its vast treasure of data of all kinds is not able to establish credible enough correlations to make lending decisions, then it does not bode well.

Monday, January 7, 2019

Can good governance deliver electoral victories in India? Would better schools and hospitals or cleaner neighbourhoods or safer streets or better quality utility services or hassle-free access to statutory services help governments retain power? Could these improvements play an important part in keeping governments in power? Is good governance an important enough electoral good?

The answers to each of the above in the affirmative is most often taken for granted and underpins much of the theoretical discourse on good governance. However, it may be worth a re-examination.

Let us assume the median politician. He is unlikely to be intrinsically motivated. His drive is most likely a single-minded desire to be in power. In fact, this is likely true of all but a handful of politicians.

Consider a program to improve student learning outcomes or traffic congestion or law and order or the delivery of any government scheme. Let us assume a system where the same state affairs in each of these areas has been persisting for years. It has neither gotten better nor worse in any significant manner. With a new program, given the weak state capacity, even when implemented with all the best intent, it is very unlikely to have anything like a transformative impact in five years. The impact of such initiatives are likely to be small and diffuse, and hardly visible to the average citizen. Suffice to say, these are really hard problems and bringing about change which is significant enough for the primary stakeholders, citizens, in a short time is almost impossible.

Then there is also the underlying assumption that good governance is a more appealing political good than sectarian/identity based and populist causes. There is no evidence that this is the case. In fact, there is a compelling theoretical argument drawing from Mancur Olson's work on collective action that populist and sectarian causes, with their concentrated impact on a cohesive minority, are likely to exert far greater influence on the politician than good governance, with its diffuse impact on the fragmented majority.

In the circumstances, the politician's incentive to support such initiatives is limited. In fact, far from supporting, the politician is likely to be put-off by reforms since by their very nature they are most likely to unsettle entrenched vested interests and rent-seekers who are likely his supporters. Also such reforms are also unlikely to favourably tilt the power balance towards another group who are his supporters.

Most importantly, electoral battles are mostly fought on state-wide or country-wide issues, which in turn surface in the most unpredictable manner and from unexpected quarters, and often just before the elections. The emergent factors most often crowd out all else. The politician understands this reality. This is one more reason for the politician to be sceptical of the value of good governance as an electoral strength.

In fact, it need not actually be the case that electoral verdicts are decided on such emergent state-wide or nation-wide factors. It could actually be that good governance matters. But that's not important. What is of relevance is what politicians collectively believe as determining factors in electoral battles.

So, is this all a lost cause?

The one scenario of promise arises when the politician (Minister or Chief Minister) gets a bureaucrat who is both intrinsically motivated (more likely than with the politician) and has a good rapport with the politician. Such a bureaucrat can then drive the change with the support of the Minister - sustainable and significant enough reform invariably needs political commitment. However, he will have to take care to ensure that the Minister's important political constituencies are not too adversely affected. Realistically, this should not be a problem given the vast scope of the reform agenda in each of these cases on a state-wide canvas.

The Minister would then have the best of all worlds - the theoretical electoral gains from any reform even while keeping his supporters happy - and leave him with the bonus of this potential electoral gain as he fights to maximise the gains from the emergent 'real' political factors.

Sunday, January 6, 2019

1. It appears that I was premature about Jerome Powell's resolve to decouple Wall Street from monetary policy decision making and stay the course with the current Fed trajectory. In a significant U-turn, most likely motivated by the market's downbeat response to the Fed's failure to indicate a pause in its December meeting and his own statement that the Fed's balance sheet shrinking was on autopilot, he said the Fed would take a "patient" approach to monetary tightening. He also said that he "wouldn't hesitate" to change balance sheet policy if needed. This reversal also vindicates President Trump who has railed against the Fed's perceived hawkishness.

The problem with monetary policy has been that it has been following Wall Street instead of responding to Main Street signals. Accordingly, despite the robust jobs report and tightening labour market conditions, and the near unanimity about the unsustainability of the equity market boom (second longest post-war boom), the Fed has again preferred to follow the stock markets and keep conditions loose to allow the bubble to remain inflated.

Powell has chickened off, like Janet Yellen in 2016 when faced with Wall Street's tumbles, from pursuing a monetary policy which balances financial market stability with economic growth.

2. Staying on with central banking, this blog has held the view that central bank communications was becoming more distortionary with increasing transparency. Now former Fed Vice Chairman, Donald Kohn has sought greater clarity with Fed communications,

Mr. Kohn believes that some of the ways the Fed now communicates to markets—by way of its “dot plot” of interest-rate projections, as well as its other forecasts—have come to be viewed as more certain than they are. He believes the Fed, both in the presentation of these views and in the remarks of officials, has reinforced the certainty of its outlook, even when officials already know much about the future is unknowable. The Fed’s quarterly forecasts should be aligned with “the rhetoric of uncertainty and data dependency and the true state of economic knowledge,” Mr. Kohn said. The Fed should stop summarizing key projections with medians, and portray the amount of uncertainty the Fed has around its various forecasts, he said. Mr. Kohn also believes the public profiles of the regional Fed officials could change. He noted the Washington-based governors are less-frequent speakers compared with the leaders of the 12 regional banks. And while the governors tend to speak about policy issues in terms of the Fed’s consensus outlook, regional bank presidents spend more time touting their own views and engaging in specifics about interest-rate changes they favor.

Some form of asymmetric ignorance is useful to keep markets honest.

3. More skeletons from the McKinsey cupboard. This time from its role in advising Boeing in 2006 to procure titanium from Andhra Pradesh in India through a partnership with an Ukrainian oligarch, Dmitry V Firtash, by paying $18.5 m in bribes to politicians and officials.

Boeing asked McKinsey to evaluate a proposal, potentially worth $500 million annually, to mine titanium in India through a foreign partnership financed by an influential Ukrainian oligarch. McKinsey says it advised Boeing of the risks of working with the oligarch and recommended “character due diligence.” Attached to its evaluation was a single PowerPoint slide in which McKinsey described what it said was the potential partner’s strategy for winning mining permits. It included bribing Indian officials.

And this characterisation of bribery is delightful,

The slide stated that Mr. Firtash’s group, Bothli Trade, “has identified key Indian officials and has crafted a strategy to gain their influences.”... The partner’s plan, McKinsey noted, was to “respect traditional bureaucratic process including use of bribes.” McKinsey also wrote that the partner had identified eight “key Indian officials” — named in the PowerPoint slide — whose influence was needed for the deal to go through. Nowhere in the slide did McKinsey advise that such a scheme would be illegal or unwise

Firtash and an Indian member of parliament from Andhra Pradesh were subsequently convicted in the US by a federal grand jury for bribery.

4. Times has another exposure, this time of the corruption and conflicts of interest within Memorial Sloan Kettering Cancel Centre. Its Chief Medical Officer, one of the most reputed breast cancer specialists, was accused of having received millions by drug and health care companies and having failed to disclose those ties more than 100 times in prestigious medical journals like Lancet and NEJM, and others had made lucrative side deals with companies to earn handsome profits.

The decision to license images of the patients’ tissue slides to a for-profit company also highlights the broader debate over the use of personal medical data, ranging from genetic information to, in this case, images of a person’s cells, for research and commercial purposes... Hospital pathologists have strongly objected to the Paige.AI deal, saying it is unfair that the founders received equity stakes in a company that relies on the pathologists’ expertise and work amassed over 60 years. They also questioned the use of patients’ data — even if it is anonymous — without their knowledge in a profit-driven venture. In addition, experts in nonprofit law and corporate governance have questioned whether Memorial Sloan Kettering, one of the nation’s leading cancer centers, complied with federal and state law governing nonprofits when it set up the deal. The experts pointed out that charitable institutions like Memorial Sloan Kettering must show that they didn’t provide assets to insiders for less than the fair market value.

Times reports of similar concerns of conflicts of interest at some of the most famous non-profit cancer research institutes in the US.

Ethicists and health experts say having leaders and researchers at nonprofit hospitals sit on corporate boards is especially problematic. When they serve on the board of a publicly traded company, they have a legal duty to the corporation and its shareholders, which can clash with their duty to their patients and primary employers. Those who sit on boards are often paid hundreds of thousands of dollars a year... A report in November in BioPharma Dive found that 12 of the 19 largest pharmaceutical and biotech companies had at least one board member who also worked at a nonprofit health care institution. A 2014 study in JAMA found that about 40 percent of the largest publicly traded drug companies had a leader of an academic medical center on their boards.

Robert Benezra, who heads a lab at Memorial Sloan Kettering that focuses on how tumors grow, is the president, chief executive officer and a board member of AngioGenex, a tiny, publicly traded biotech that is developing drugs to treat cancer based on the discoveries made in his lab. Though he takes no salary from AngioGenex, Dr. Benezra owns nearly nine percent of the company he helped found through stock or options, setting him up for a lucrative payday if the company is acquired or its drugs come to market.

5. Closer home in India, Uday Kotak, one of the self-cultivated champions of corporate India throws aside all corporate governance norms to delay, obfuscate, and litigate on compliance with RBI's regulatory requirements so as to retain shareholding control over his holding companies even at the risk of exposing the Kotak Mahindra Bank depositors to the entire group's risks.

It is very apparent that Uday Kotak as chairman of a committee on corporate governance argues for greater than the minimum transparency but Uday Kotak as promoter-CEO of KMB practices the bare minimum.

And this is telling testament to India's financial media,

Strangely, for a bank with a market cap of Rs 2,36,386 crore which adopts the reckless action of filing a strongly worded writ petition against the banking regulator, the media appears uninterested to disclose the contents of the writ... The writ contained correspondence which is rarely seen by the public, and the business media should have actively competed to disclose and analyse its contents. But in doing so, the media would have had to criticise the conduct of one their much-sought-after CEOs. CNBCTV18 conducted a panel discussion on the issue, but such is Uday Kotak’s stature that not a single panelist was willing to publicly reprimand him and the bank; instead they gave excuses justifying the bank’s conduct. Hence, apart from merely reporting that the bank had filed a writ and that the Bombay High Court had rejected the stay, the business media have been content to sit it out as mere spectators.

8. Amazon improvises with its business model and logistics chain to penetrate rural Indian market.

The Seattle giant has modified its app to work with inexpensive smartphones and patchy cellular networks. It has added hundreds of thousands of Indian language descriptions of products and videos for those who can’t read, and it has opened physical Amazon stores to walk people through the process of ordering online. It brought on tens of thousands of local distributors to deliver packages, often by bicycle down dirt roads, where it will accept cash or digital payment on delivery...

Amazon is enlisting the small stores as package depots along its distribution network. Other small retailers have become Amazon learning centers for new shoppers. Arjun, 29, runs a tiny Amazon store in Maddur, in the southern state of Karnataka, where people can get help learning how to search and order. Customers walk in with screenshots of something their favorite Bollywood stars wore, and Mr. Arjun, who uses one name, gets the search started. Seated at linked computer screens, the customers, most of whom aren’t comfortable with English or typing, can follow along as he pulls up options. He helps them pick the right size using a chart on the wall and a foot measuring device. Later, customers come back to pick up their orders and pay cash at the store. There is even a changing room so they can try on clothes before paying...

Amazon used data showing the location of people searching its site to figure out which parts of India need more delivery capability. Then it reached out to small businesses for help. Nogenchandra Das, 31... signed up for the “I Have Space” program, along with more than 20,000 mom-and-pop stores, offering to take packages and deliver in neighborhoods for a commission. Amazon gave him a uniform, a bag and a week of training. A motorcycle deliveryman brings about 25 packages a day from a small distribution center nearby. Customers can come pick them up at his shop, or he will deliver them on his own motorcycle.

9. For the December quarter, new investments in India have plunged to their lowest since mid 2004, and with stalled projects at record levels. Indian companies announced new projects worth Rs 1 trillion, 53% lower than previous quarter and 55% lower than a year-ago. For new private sector projects, it fell 62% and 64% respectively, and 37% and 41% for public sector.

As regards stalled projects, the CMIE data shows its value increased marginally, with private sector stalling rate hovering at near record high of 24% and overall stalling rate is slightly lower at 11%.

Power sector formed 35.4% of stalled projects. As to the reasons for stalling, the biggest were lack of funds, problems with fuel and raw materials, and unfavourable market conditions.

Friday, January 4, 2019

The Mission Bhagiratha program of the Government of Telangana that provides treated water through a piped network is truly an impressive achievement. If the numbers are to be believed, this has to stand up with the best in terms of project execution efficiency.

Sample this,

Launched in August 2016, Mission Bhagiratha, Telangana’s ambitious project to supply drinking water to every household outside municipal corporation limits, is nearing its March 31, 2019 deadline. And government officials say 1,00,200 km of the 1,04,749-km network of pipelines — around two-and-a-half times the Earth’s circumference — has been laid... As of today, drinking water reaches bulk collection points in 22,947 villages. The deadline to provide water at these collection points to the remaining 1,021 villages is January 10. The deadline to complete the project to provide drinking water through individual household taps is March 31, 2019... houses in 17,000 habitations were provided individual drinking water tap connections as on December 18, 2018. These households will start receiving purified drinking water shortly. About 95 per cent work of laying pipelines to the remaining 6,968 villages is completed and only last-mile pipes and taps have to be fixed... The 49,120-km primary pipeline network has already been laid through which water is being pumped. Around 51,080 km of a separate 55,629-km intra-village pipeline network has been completed.

Those conversant with the challenge of executing such projects in such tight timelines will vouch that this is a big deal, real world-class project execution, even with the discount for the quality and other parameters.

Hopefully it upends the conventional wisdom on rural drinking water supply and made Indian states re-imagine the delivery of drinking water to villages.

Such projects naturally raise concerns across the spectrum of opinion makers. Will the water sources be always available? How will the infrastructure facilities be maintained? How will the leakages be plugged? Will water be billed? Who will pay for it? How will the bills be collected? How do we ensure quality of supply is acceptable? Given leakages and collection problems, will the delivery be efficient? And so on.

Needless to say, all of these are important questions. And for sure, in the coming years, there will be several examples of villages falling off the grid for various reasons and going back to bores, treatment facilities falling into disrepair, water leakages across the network, water pilferage and uncollected arrears, episodes of people in villages falling sick due to water contamination, mounting electricity arrears, discovery of poor quality works and materials, and so on. Several of them will, ex-post, be decried by opinion makers as being examples of populist misadventures and bureaucratic inefficiency.

All fair points for arm-chair analysis, research publications and op-eds, and talking heads on television.

But they miss the point about the re-imagination here. There is no developed country which supplies drinking water to the predominant share of its rural population through ground water bores. They all deliver surface water treated and piped to small habitations. No surprise here since this is perhaps the only way to sustainably and at scale deliver drinking water to population habitations, rural or urban.

The journey to that destination can happen either in a planned and piecemeal manner or in the one-swoop manner of Telangana. Opinion makers and consultants would prefer the former. But if the Telangana government decided to plan everything and mitigate all these risks before venturing out with this project, it can safely be said that it would never have taken off. And Telangana would have lost the opportunity to break out of an entrenched retrograde development narrative and adopt perhaps the only sustainable approach to delivering drinking water to rural areas. Albert Hirschman's principle of hiding hand assumes relevance here.

Undoubtedly, in the years ahead, all the aforementioned scenarios will materialise and the government will be criticised for this plunge.

Looking ahead, perhaps the only fair prospective criticism of the government, in my opinion, would be, apart from egregious project execution failures and corruption, for not having put in place the required mechanism and response to emergent problems. And the latter failing is most likely.

Wednesday, January 2, 2019

1. A fascinating account of corporate relationship building associated with political turnovers in China.

In this paper we empirically study how firms build their relationship with local government officials in China. We focus on two mechanisms: perk spending and personnel changes. We find that, following the turnover of the Party Secretary or mayor of a city in China, firms (especially private firms) headquartered in that city significantly increase their “perk spending” (e.g., travel expenses, business entertainment expenses, overseas training expenses, board meeting expenses, company car expenses, and meeting expenses)... we also find that the perk expenses increase more when the demand to build relation is stronger, e.g., when the incoming official is young, or is from a different city, and when the firm is less connected. This effect is weaker when officials are more reluctant to accept perks due to elevated risks of discipline, for example, after the 18th National Congress of the Chinese Communist Party, or after an arrest of local politicians for corruption cases. Our evidence also shows that firms with more perk expenses receive more future benefits such as government subsidy and access to financing, but do not have better future performance as measured by returns on assets or equity.

Interestingly, the second relation building mechanism, personnel change, is only effective among local SOEs. Local political turnover tends to be followed by changes of Chairmen or CEOs of state-owned enterprises located in that city, particularly for those controlled by the local government. In contrast, private firms and SOEs that are controlled by the central government do not seem to engage in personnel changes following the turnover in the local government leadership. We also find that those Chairmen or CEOs of local SOEs are the protégés of the local government officials: they are less likely to be replaced in the future as long as their “mentors” remain in offices.

Fundamentally, though regional (province, city, county, and township) government officials are appointed by the central government (the party) and not appointed by local electorate, the local governments have large fiscal independence - regional governments make up over 70% of the fiscal spending in China. The federal government put in place a tournament system to incentivise regional government officials - those achieving fast economic growth were promoted and those with poor performance penalised. Thus officials at different levels had both the incentive and fiscal resources to compete and promote local economic growth.

He points to two features of the country's economy,

First, the government takes a central role in driving the economy through its active investment in infrastructure. Second, agency problems in the government system generate a rich set of phenomena in the Chinese economy, including not only rapid economic growth propelled by the tournament among local governors but also short-termist behaviors of local governors, which directly affect China's economic and financial stability... The latter channel helps to explain a series of challenges that confront the Chinese economy, such as overleverage through shadow banking and unreliable economic statistics.

The focus on economic growth on the one hand encouraged investments in infrastructure (since it contributed to aggregate economic growth), but on the other hand encouraged local officials to over-report growth and also leverage to expand their fiscal budget and over-invest.

The agency problems triggered an unhealthy competition between provincial governors to over-report and leverage up. While the central government was aware of the over-reporting and leverage and tried to control it, their support for innovations also meant that the governors had enough flexibility to over-report and hide leverage in innovative financing approaches (eg different types of local government financing vehicles and shadow banks). Short-termist behaviours prevailed and motivated governor to indulge in them.

3. In another paper, Wei Xiong and Chang Liu have an excellent account of the evolution of China's real estate market. This summary of the current challenge is apt,

First, housing holdings are the biggest component of Chinese households’ asset portfolios, partly due to a lack of other investment vehicles for both households and firms in China’s still underdeveloped financial markets. Second, China’s local governments heavily rely on land sale revenues and use future land sale revenues as collateral to raise debt financing through “Local Government Financing Platform” (LGFP). Third, firms also rely on real estate assets as collateral to borrow, and since 2007, firms, especially well-capitalized firms, have engaged heavily in acquiring land for investment purposes. Finally, banks are heavily exposed to real estate risks through loans made to households, real estate developers, local governments, and firms that are either explicitly or implicitly backed by real estate assets.

They explain the trajectory of policy led development of real estate market. In 1988, the government amended constitution to allow land transactions - it was however not ownership, but "land usage right" for a fixed period of time (upto 70 years for residential use). In 1994, the government allowed for the first time government employees to purchase full or partial property rights, at subsidised prices.

In 1998, this welfare housing system with its discount was abolished and full-fledged private housing was allowed. This privatisation of housing released the pent-up demand for housing asset accumulation by households and catalysed the real estate market. It also alleviated credit constraints and stimulated entrepreneurship. Simultaneously, banks began to provide residential home mortgages at subsidised interest rates, and these rates were lowered five times between 1998-2002 to boost private house purchases.

Further, in 1998, the de-jure ownership of land was transferred from the central government to the local governments. They were also authorised to sell usufruct/leasehold rights over their lands. To restrain corruption in sales, in 2002 it was mandated that all residential and commercial leasehold sales be through auctions.

Then in the early 2000s, urbanisation became the growth strategy, though it was regulated with the hukou permit system (till its abolition in 2014, except in case of some very large cities). This led to the development of numerous greenfield townships which further boosted the real estate market. Doubtless it led to excesses and ghost towns, but over time, once built and infrastructure completed, these towns became fully occupied. All through this, the government fulfilled its responsibility in supporting growth by developing all the required infrastructure in quick time.

Land was similarly central to industrial growth - while residential and commercial land prices boomed, industrial land prices remained stagnant since local governments offered it at heavily subsidised prices to attract industries.

The housing boom also explains China's high savings rate and low consumption. The authors feels that the relatively high, 30%, minimum down payment condition for mortgage loans mitigates some of the risks that banks face from a property market collapse.

This summary of what backstops the real estate market is important,

To the extent that local governments are local monopolies of land supply and heavily rely on land sale revenues for their own fiscal budgets, the markets for residential properties and commercial real estate are crucially tied to land sale policies and strategies of local governments. This is a special feature of China’s real estate market.

The under-developed and restrictive financial market too is perhaps a backstop for the real estate market.

Two further reforms were important in steering local governments to focus more on real estate to realise resources. The Tax Sharing Reform Law 1994, apportioned a greater share of the tax revenues (all collected by local governments and shared with the centre) to the central government. The Budget Law 1995 prohibited local governments from running budgetary deficits or obtaining external financing. Both these forced local governments to expand their non-budgetary finances, especially from land sales.

In 2008, in response to the global crisis, the central government eased the 1995 restrain on budget deficits and allowed local governments to float local government financing vehicles (LGFVs) and raise debt. This, as we know now, spawned its set of excesses. The LGFV is an entity to which some land reserves are transferred or which owns future land sale revenues. It then uses this collateral to raise money from banks and elsewhere. The LGFV can carry an implicit or explicit local government guarantee.

According to Chinese National Audit Office, in 2013 total volume of outstanding local government debt was 19.2% of GDP, of which 37.23% used future land sale revenue as collateral. Further, governments have an explicit obligation in 61% of the debts. Since then, restrictions on bank lending to LGFVs has pushed the costlier and opaque shadow banking system to prominence as lenders to LGFVs.

In recent years, the government has tried out some reforms to diversify away from land as a source of local government revenue. In 2011, property tax was trialled on second homes in Shanghai and Chongqing, but not expanded due to fears of public opposition and a real estate crash.